Buying Infrastructure Builders
Comment of the Day

February 14 2012

Commentary by Eoin Treacy

Buying Infrastructure Builders

Thanks to a subscriber for this informative report by Curt Luaner and Valerie Zhang for Deutsche Bank focusing on the MLP sector. Here is a section:
Macro Plusses in Supply; Demand; Price: Extra Boost From Oil & Liquids:
Specific conclusions detailed in this report: US natural gas demand growth of 1.8%% per year (Figure 16); a rise of 4.4% per year in power generation; North American natural gas supply growth of 2% per year (Figure 13); 11% growth in shale production; oil production growth in North America of 5.6%.(Figure 14).

Fundamentals Promote Extension of Recent Valuation Gains:
With MLP's having shown a 13% total return in 2011 vs a 2% rise in the S&P 500 (including dividends), the favorable attributes of the sector are not undiscovered. However, the hard assets base and the essential infrastructure nature of the growth make for a unique secular growth story. The current yield premium of 391 basis points vs the 10 year Treasury compares to 300 bps historically. In the environment of 2006-2007, the yield differential fell to 130 bps before rising to over 500 bps in the crisis of 2008. The average for 2010-2011 was 365 bps.

Risks: Commodity Prices, Capital Markets, Regulation and Legislation:
The risks to our thesis are: commodity prices, because of the reliance on producers to continue drilling and producing oil and gas; capital markets, because of the need for both equity and debt capital to fund the capital expenditures of the industry; regulatory or legislative actions that could slow drilling in the shale plays or change the favorable and attractive tax structure of the sector.

Eoin Treacy's view There have been two primary drivers behind investor interest in energy MLPs over the last few years. The first is the favourable tax treatment they receive as pass through entities which contributes to the sector's higher than average yields. The second is they offer one of the best plays on the secular bull market in domestic US energy expansion and development. Shale gas is putting downward pressure on commodity prices. Companies dependent on a high natural gas price are struggling as a result. However, increased volumes have been a boon for pipeline and gas storage companies.

I have incorporated dividend yield and P/E data into the results of this Chart Library Performance Filter of energy MLPs. The 56 instruments included have an average yield of 3.64%. The better performing instruments share a similar pattern.

Enterprise Products Partners, Western Gas Partners, Kinder Morgan Energy Partners, Magellan Midstream Partners, Plains All American Pipeline, ONEOK Partners, MarkWest Energy Partners, DCP Midstream Partners, Chesapeake Granite Wash and Rose Rock Midstream have all broken out of multi month ranges in February and while some are becoming increasingly overextended relative to their respective 200-day MAs, sustained moves below them would be required to question medium-term uptrend consistency.

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